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OPEC Can Only Push Oil Prices So High

With oil prices back up above $50 per barrel, more and more shale companies could find it profitable to resume drilling. But the improved prospects for shale companies, and the subsequent uptick in drilling and production, could once again put pressure on prices.

Improved drilling techniques, efficiencies, and the ability to extract more oil and gas per drilled well has allowed for cost savings across the industry. That could ultimately put a ceiling on oil prices not just in 2016 but over the long-term, investment bank Credit Suisse recently said. Higher oil prices will lift all boats, but “shale may ultimately be too productive as WTI approaches $70/bbl. As a result, we have taken our long-term WTI forecast from $67.50/bbl to $62.50,” Credit Suisse analyst wrote.

The result could be a shale band, in which supply falls when prices dip below roughly $40 per barrel, but production rebounds above, say, $50 per barrel. But if prices get too high – closer to $60 per barrel and higher – then enough supply comes back online to push prices back down again. This theory has been offered from various outlets over the past year or two, but it hasn’t truly been tested yet.

There have been a few instances in which oil rallied but eventually ran out of steam – in the summer of 2015 and to a lesser extent in the summer of 2016 – which provides some evidence for the shale band theory, but the real test will come when shale production starts to rise again and at what price level. If the shale band theory ultimately plays out, and the market is restricted by a floor and ceiling, the upshot is that oil prices could remain low for years to come.

Interestingly, Credit Suisse says this could be beneficial to some drillers. While pretty much every company would like to see oil prices go much higher, shale producers with lower costs that can turn a profit with oil trading below $60 per barrel may thrive in this environment. “Operators at the low end of the cost curve in particular would benefit from crude remaining more range bound as returns at current prices justify development and less activity in higher cost basins would likely push out pending cost inflation,” Credit Suisse says. Related: U.S. Rig Count Rises To 8 Month High As Permian, Eagle Ford See Decline

In other words, if oil prices rose too high – back to triple-digit territory, for example – then the cost reductions achieved over the past two years would likely go up in smoke. The cost of equipment, drilling services, rigs and personnel would all see inflation along with the oil price. So shale drillers comfortable with $50 oil may not necessarily be desperate to see oil prices spike much higher.

These drillers are increasingly found in the Permian Basin in West Texas, where a land rush continues. Multiple layers of shale can be found in the Permian, which allows companies to tap more oil and gas per vertical well. The returns are better, and as a result, breakeven costs are lower. That has companies packing up from the rest of the country and moving to West Texas. RSP Permian Inc. just agreed to pay $2.4 billion to take over Silver Hill Energy Partners. The deal means that RSP is essentially paying about $45,000 per acre to drill in the Permian’s Delaware Basin, which Bloomberg says could be the basin’s highest price per acre ever recorded. Related: Russia Shifts Focus From Oil To Agriculture

The rush to the Permian has come at the expense of places like the Bakken. North Dakota’s oil production dropped below 1 million barrels per day in August, the first time that the state produced less than 1 mb/d in two years. In August the state produced 981,000 barrels per day, down from a peak of 1.23 mb/d in December 2014. "It does send a signal to the world markets that U.S. producers are serious about reducing activity, reducing costs, reducing production and I think that should help support the recent price increase we saw," Lynn Helms, director of North Dakota’s Department of Mineral Resources, told reporters.

It remains to be seen if the Bakken will rebound with oil prices in the $50s per barrel. But for North Dakota, that may be all they can hope for – if Credit Suisse’s prediction plays out, oil prices may not rise much higher than that for a very long time.

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2014/2015 drilling schedules in the lower 48 were built on 70-100 dollar oil and a bubble in capital investment via ipo, unsecured and secured debt. This game is over and only a select few companies by comparison, with the best acreage and finances, can raise much capital and continue to drill. Remember, the minerals are not owned but leased, so much of the secondary acreage will never again be drilled unless prices go back above 70 or technology and infrastructure drastically improve. I.e., these are wasting assets. 50-100 billion must now be spent every year to keep the lower 48 production flat and new drilling in the GOM is all but dead.

So the question is not whether the U.S. Production will continue to slowly decline but at what point does Saudi aramco decide to take the foot of the break. They could be in a position next year that they need to burn 50 billion to prop up their own banks that are closing on 100 percent loan/deposit ratios. U.S. Banks went from 90 to 65 percent in the last six years so we are in a better relative position. Most of the U.S. Firms now standing will survive, so the Saudis and partners need to figure if they can cut production and both increase revenues while preventing another bubble in the lower 48. Clearly Brazil and the GOM are crippled.

A Saudi cut by 1 million bpd would likely send prices back into the mid 60s while providing them with @ 50 billion in additional annual revenues. And clearly they need it.